The real estate race to net zero
The UK government is committed to achieving net zero carbon by 2050. Towards the end of last year, in the run up to COP26, it published several documents, including the Net Zero Strategy, the white paper on energy and the strategy on heat and buildings. These contain details of the measures the government intends to introduce to help achieve the net zero target. With buildings accounting for nearly a quarter of UK greenhouse gas emissions, it’s no surprise that the Government’s strategy focuses primarily on decarbonising the built environment.
Widely perceived to have been slow to adapt to the environmental agenda in the past, no part of the real estate sector will be spared from the government’s current intentions. Below, we explore some of the key measures that will impact owners, occupiers, developers and lenders both now and longer term; and the role the sector can play in helping to achieve the ambitious 2050 goal.
Heat and buildings strategy
The Heat and Buildings strategy recognizes that virtually all heat in buildings (commercial and residential) will need to be decarbonized if net zero goals are to be achieved. The strategy focuses on delivering a carbon-free electricity system by 2035. To achieve this, the strategy strongly favors the use of electric heat pumps. Gas boilers will be banned in new construction by 2025 and new gas boilers will no longer be available for sale by 2035. A decision on the use of hydrogen gas in heating systems has been postponed to 2026.
Sustainability is at the heart of new build construction, so developers need to take it into consideration. Under new regulations in effect from June 2022, carbon emissions from new homes must be around 30% lower than current standards and emissions from other new buildings, such as shops and offices, must be reduced by 27%. London-based promoters already know that the London plan keeps them on an even higher level. New developments must therefore include modern heating systems, smart meters and energy storage to help meet government targets.
The challenge of retrofitting new heating systems in older buildings is a separate issue. Building improvements are labor-intensive and involve highly skilled jobs, which will cost investors and owners alike. However, decarbonisation measures lead to lower operating costs, especially for heating and cooling, so that in the long term, renovated buildings should be attractive to tenants and lead to higher rents.
Minimum Energy Efficiency Standard (MEES) for Leases
Building owners will be aware that since 2018 (subject to certain exemptions), a landlord must not grant a new lease (or renewal lease) of a commercial building without a valid EPC rating of ‘E’ or higher . Failure to comply with the law risks a fine of up to £150,000 for the owner. From 1 April 2023, this obligation will extend, so that (again, subject to exemptions) an owner cannot Continue lease a commercial building under an existing lease unless the building has an EPC rating of “E” or higher (for domestic properties, this rule applies as of April 2020).
The government’s ultimate intention is to raise the minimum EPC rating for domestic properties to a ‘C’ rating by 2028 and for commercial properties to a ‘B’ rating by 2030. However, some commentators believe that the proposed changes will still not yield the results. the government hopes for and therefore additional regulation or the removal of exemptions may be required, which would pose further challenges in the future.
Homeowners are most likely to bear the burden of the MEES. The main compliance obligations fall on them and the most likely constraint will be the financial burden of upgrading non-compliant assets coupled with potential loss of revenue when a building is unsuitable for letting. On the other hand, energy efficiency improvements may offer potential for increased rent. There may also be opportunities for investors to acquire new assets, below the minimum standard, at a reduced cost.
Lenders should also beware. When a building does not meet the MEES, the value of the lender’s guarantee could be reduced. Indeed, when a lender takes possession following a default, it could become the owner responsible for compliance with the MEES. In addition, government targets for lenders to improve the average energy performance certificate rating of their loan portfolio are in the works. On the positive side, lenders could take advantage of the lack of government support for homeowners to finance energy efficiency improvements by opening up a new deal flow.
Charging stations for electric vehicles
The Net Zero strategy includes a £1.5 billion commitment to fund the installation of an electric vehicle (VE) charging stations in streets, highways, workplaces and homes. Given the government’s plan to end the sale of new petrol and diesel cars in the UK by 2030 and the relatively slow installation of electric vehicle charging stations compared to the growing demand for electric cars , this new investment is essential.
The new regulations in force from June 2022 require new homes with on-site parking to have an EV charging station; and new non-residential buildings with more than ten on-site parking spaces to have at least one charging point and cable trays for one in five spaces. Additionally, there are requirements for residential and non-residential buildings undergoing major renovations with on-site parking to have a number of electric vehicle charging stations and cable trays. These regulations will make the installation of EV charging stations a must for many landowners and developers, as is already the case for many developers in the capital subject to the London Plan.
Installing electric vehicle charging stations in any building should make it more attractive to tenants, which can lead to higher rents or land values. However, owners in particular need to consider a range of factors – is planning or other consent required for electric vehicle charging stations? Who will bear the initial cost of the installation and is the existing electricity supply sufficient? Once installed, who will maintain the charging stations? How will electricity be recharged to tenants? Will EV charging stations have an impact on rent reviews?
Landlords, developers and lenders will certainly have their work cut out over the next few years, and the legal industry is taking steps to address this.
The Chancery Lane Project – a non-profit collaborative network of legal professionals, with expertise in a range of sectors and industries – is developing model climate clauses for incorporation into legal documents to help organizations achieve the net zero, including in the real estate sector. For example, the project includes a clause intended to be inserted in a lease, to encourage landlords and tenants to reuse goods and materials when the parties are required to repair, modify, transfer or decorate the premises.
This is also undoubtedly the time to implement the provisions of the “green lease”. A green lease includes provisions encouraging all parties to reduce the environmental impact of the leased property, the objective being to allow occupation and management that are more respectful of the environment and ultimately to reduce the environmental footprint of a property. . There are also options if parties to an existing lease wish to “go green”; they can enter into a separate agreement setting out measures to improve a property’s environmental performance. The provisions we often see used are those set out in the Better Buildings Partnership Green Lease Toolkit. These provisions are not new – the Green Lease Toolkit was developed in 2013 – so they have been ‘tried and tested’ in the market to a much greater extent than the model clauses developed by the Chancery Lane project. Given the pressure to achieve net zero, these provisions are quickly becoming the norm.
The government’s net zero goal and the policies the government intends to implement to achieve that goal mean that changes will be forced upon developers, landlords, lenders and occupiers. In the past, the real estate sector has been slow to adapt to the demands of the environmental agenda, but like many other industries, the sector has no choice but to catch up now.